Business Model Test | Ind AS 109 | Debt Instruments | CA Final FR | Held to Collect vs Trading

Why are you holding this financial instrument?

Are you holding it because you want to receive the contractual cash flows that the instrument will generate? In other words, your intention is not to sell it—you simply want to collect the cash flows as they become due.

There are three possible business models for holding a debt instrument.

First: You hold the instrument only to collect the contractual cash flows. You do not intend to sell it. In simple words, this is similar to a held-to-maturity approach.

Second: No, that's not the case. You hold the instrument both to collect the contractual cash flows and to sell it whenever it makes business sense. If earning the interest is beneficial, you continue holding it. If market conditions are favourable, you may sell it. So, your objective includes both collecting contractual cash flows and selling the instrument.

Third: You hold the instrument only for the purpose of trading. The objective is to earn profits from buying and selling, not from collecting contractual cash flows.

So, these are the three business models under the Business Model Test.

Now notice something important.

In all these business models, the standard repeatedly refers to contractual cash flows.

The term contractual cash flows is relevant only for debt instruments. Debt instruments, such as bonds and loans, contain contractual rights to receive principal and interest.

An equity instrument does not provide contractual cash flows in this sense. Dividends are discretionary and are not contractual obligations.

Therefore, the Business Model Test and the Cash Flow Characteristics Test (SPPI Test) are applicable only to debt instruments.

For equity instruments, these tests are not relevant. Equity instruments follow a separate classification approach under FVTPL and the FVOCI election.

So, everything we have discussed over the last few minutes is purely for debt instruments.

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